The Securities and Exchange Commission (SEC) has taken some steps toward developing a conflict minerals disclosure rule, but it has not issued a final rule. For example, SEC published a proposed rule in December 2010 and has gathered and reviewed extensive input from external stakeholders through comment letters and meetings. SEC has also announced, on several occasions, new target dates for the publication of a final rule. In July 2012, SEC announced that the Commission will hold an open meeting in August 2012 to consider whether to adopt a final rule. According to SEC officials, various factors have caused delays in finalizing the rule beyond the April 2011 deadline stipulated in the act, including the intensity of input from stakeholders and the public; the amount of time required to review this input; and the need to conduct a thorough economic analysis for rule making.

Various stakeholders have developed initiatives that may help covered companies comply with the anticipated rule, but some initiatives have been hindered by SEC’s delay in issuing a final rule. Industry associations, multilateral organizations, and other stakeholders have developed global and in-region sourcing initiatives, which include the development of guidance documents, audit protocols, and in-region sourcing systems. These initiatives may support companies’ efforts to conduct due diligence and to identify and responsibly source conflict minerals. In the absence of SEC’s final rule, however, stakeholders note that uncertainty regarding SEC’s reporting and due diligence requirements has complicated their efforts to expand and harmonize their initiatives. For example, in the absence of a final rule, one initiative is facing difficulty engaging additional participants, while stakeholders’ efforts to harmonize two initiatives have been hindered.

Little additional information on the rate of sexual violence in eastern Democratic Republic of the Congo (DRC) and neighboring countries has become available since GAO’s 2011 report on that subject. For example, only one population-based survey has been published on sexual violence in Rwanda, and it reports that 22 percent of women ages 15-49 have experienced sexual violence there in their lifetimes. No additional surveys have been conducted in eastern DRC; however, one organization is currently conducting a survey and another is planning to conduct a survey there in 2012.

The New York Court of Appeals will hear an appeal by former AIG executives Hank Greenberg and Howard Smith asserting that the state attorney general's action against them for violating the state's Martin Act is preempted by federal legislation --PSLRA, NSMIA and SLUSA -- that establishes a uniform federal standard for securities litigation. In State of New York v. Greenberg, the state charged the executives with violating the statute because of their role in fraudulent transactions designed to portray an unduly positive picture of AIG's loss reserves and underwriting performance. The trial court denied defendants' motion for summary judgment, and the Appellate Division affirmed, 95 A.3d 474 (Ist Dept. 2012(one justice dissenting). David Boies is representing Greenberg.

The SEC announced that the Amish Helping Fund (AHF), a non-profit corporation that offers securities to fund mortgage and construction loans to young Amish families in Ohio, will ensure that its investors receive more timely and accurate information under a deferred prosecution agreement reached with the SEC. The SEC investigated the AHF, which was formed in 1995 by a group of Amish elders interested in furthering the Amish way of life, and alleges that AHF’s offering memorandum, drafted in 1995, was not updated for 15 years and thus contained material misrepresentations about the fund and the securities being offered.

The SEC release, however, goes on to state that:

Despite violating federal securities laws by disseminating a stale offering memorandum, the SEC found no evidence that AHF investors suffered any undue harm or investment losses as a result of these misrepresentations.

When informed of its alleged violations by the SEC, AHF immediately cooperated, updated its offering memorandum, and took other significant remedial steps in an expedited manner. Therefore, the SEC has entered into a Deferred Prosecution Agreement (DPA) and will not file an enforcement action against AHF provided it adheres to the provisions of the agreement. AHF is entering into a DPA with the SEC as part of the Cooperation Initiative the Enforcement Division announced in 2010 to facilitate and reward cooperation in SEC investigations.

Under the terms of the DPA, the SEC will refrain from filing an enforcement action against AHF if the company complies with certain undertakings. Among other things, AHF has updated and corrected its offering materials and agreed to register its new securities offerings and provide current investors with timely and accurate financial information.

The SEC charged the U.S. investment banking subsidiary of Japan-based Mizuho Financial Group and three former employees with misleading investors in a collateralized debt obligation (CDO) by using “dummy assets” to inflate the deal’s credit ratings. The SEC also charged the firm that served as the deal’s collateral manager and the person who was its portfolio manager. According to the SEC’s complaint against Mizuho Securities USA Inc., the firm made approximately $10 million in structuring and marketing fees in the deal.

Everyone charged by the SEC agreed to settlements without admitting or denying the charges. Mizuho consented to the entry of a final judgment requiring payment of $10 million in disgorgement, $2.5 million in prejudgment interest, and a $115 million penalty. The settlement, which requires court approval, also permanently enjoins Mizuho from violating Sections 17(a)(2) and (3) of the Securities Act.

The SEC alleges that Mizuho structured and marketed Delphinus CDO 2007-1, a CDO that was backed by subprime bonds at a time when the housing market was showing signs of severe distress. The deal was contingent upon Mizuho obtaining credit ratings it used to market the notes to investors. When its employees realized that Delphinus could not meet one rating agency’s newly announced criteria intended to protect CDO investors from the uncertainty of ratings downgrades, they submitted to the rating firm a portfolio containing millions of dollars in dummy assets that inaccurately reflected the collateral held by Delphinus. Once the firm rated the inaccurate portfolio, Mizuho closed the transaction and sold the notes to investors using the misleading ratings. Delphinus defaulted in 2008 and eventually was liquidated in 2010. Mizuho sustained substantial losses from Delphinus.

According to the SEC’s settled administrative proceedings against the three former Mizuho employees responsible for the Delphinus deal, Alexander Rekeda headed the group that structured the $1.6 billion CDO, Xavier Capdepon modeled the transaction for the rating agencies, and Gwen Snorteland was the transaction manager responsible for structuring and closing Delphinus. Delaware Asset Advisers (DAA) served as Delphinus’s collateral manager and the DAA portfolio manager was Wei (Alex) Wei.

In the related administrative proceedings against Rekeda, Capdepon, and Snorteland, the SEC found that Rekeda violated Sections 17(a)(2) and (3) of the Securities Act, and Capdepon and Snorteland violated Section 17(a). Rekeda and Capdepon each agreed to pay a $125,000 penalty while the decision on whether there will be a penalty for Snorteland will be decided at a later date. Rekeda agreed to be suspended from the securities industry for 12 months, Capdepon and Snorteland each agreed to be barred from the securities industry for one year, and all three agreed to cease and desist from further violations of the respective sections of the Securities Act they violated.

The SEC instituted settled administrative proceedings against DAA and Wei based on their post-closing conduct. DAA consented to the entry of an order requiring the firm to pay disgorgement of $2,228,372, prejudgment interest of $357,776, and a penalty of $2,228,372. Wei consented to the entry of an order requiring him to pay a $50,000 penalty and suspending him from associating with any investment adviser for six months. Both DAA and Wei consented to cease and desist from violating Section 17(a)(2) and (3) of the Securities Act and Section 206(2) of the Advisers Act.

The SEC announced that two options traders whom the agency charged earlier this year with short selling violations have agreed to pay more than $14.5 million to settle the case against them. According to the SEC, Jeffrey A. Wolfson and Robert A. Wolfson engaged in naked short selling by failing to locate shares involved in short sales and failing to close out the resulting failures to deliver. According to the SEC’s orders settling the administrative proceedings against the Wolfsons, they made illegal naked short sales from July 2006 to July 2007. The Wolfsons made approximately $9.5 million in illegal profits from their naked short selling transactions.

The SEC's Office of the Chief Accountant recently published its final staff report on the Work Plan related to global accounting standards.(Download Ifrs-work-plan-final-report[1]) At the time the SEC directed the staff to prepare the work plan, it indicated that the information obtained through the Work Plan would aid the Commission in evaluating the implications of incorporating International Financial Reporting Standards (IFRS) into the financial reporting system for U.S. companies.

This essay explores the line between private and public markets. I propose a two-tier market system to replace initial public offerings. The lower tier would be a private market restricted to accredited investors; the top tier would be a public market with unlimited access. The transition between the two markets would be based on issuer choice and market capitalization, followed by a seasoning period of disclosure and trading in the public market before the issuer would be allowed to make a public offering. I argue that such system would promote not only efficient capital formation, but also investor protection.

Two founders of Provident Royalties LLC, Brendan Coughlin and Henry Harrison, were indicted last week on multiple counts of mail fraud. From 2006-09, firms sold Provident oil and gas deals promising 18% returns to over 7500 investors for a total of $485 million. The SEC settled civil charges earlier this year, and FINRA suspended from the industry Coughlin and Harrison for two years. Inv News, Provident Royalties founders indicted in $485M private placement fraud case

The SEC voted to require the national securities exchanges and the Financial Industry Regulatory Authority (FINRA) to establish a market-wide consolidated audit trail that will significantly enhance regulators’ ability to monitor and analyze trading activity. The new rule adopted by the Commission requires the exchanges and FINRA to jointly submit a comprehensive plan detailing how they would develop, implement, and maintain a consolidated audit trail that must collect and accurately identify every order, cancellation, modification, and trade execution for all exchange-listed equities and equity options across all U.S. markets. According to the SEC's release:

Currently, there is no single database of comprehensive and readily accessible data regarding orders and executions. Each SRO instead uses its own separate audit trail system to track information relating to orders in its respective markets. Existing audit trail requirements vary significantly among markets, which means that regulators must obtain and merge together large volumes of disparate data from different entities when analyzing market activity.

A consolidated audit trail will increase the data available to regulators investigating illegal activities such as insider trading and market manipulation, and it will significantly improve the ability to reconstruct broad-based market events in an accurate and timely manner. A consolidated audit trail also will significantly increase the ability of regulators to monitor overall market structure and assess how SEC rules are affecting the markets, and will reduce the regulatory data production burdens on SROs and broker-dealers by reducing the number of ad hoc requests from regulators presently.

The new rule becomes effective 60 days after its publication in the Federal Register. SROs are required to submit the NMS plan to the Commission within 270 days of the rule’s publication in the Federal Register. Once the Commission approves the NMS plan, the SROs are required to report the required data to the central repository within one year, and members of the SROs are required to report within two years. Certain small broker-dealers will have up to three years to report the data.

The SEC's adoption of a consolidated audit trail through the development of a National Market System (NMS) plan is an important step that will enhance regulators' ability to conduct surveillance of trading activity across multiple markets and perform market reconstruction and analysis. FINRA looks forward to working with the other SROs to submit an NMS plan that will help close the regulatory data gaps that exist today. FINRA believes that comprehensive intermarket surveillance is essential to ensuring the overall integrity of the U.S. securities markets and maintaining the confidence of investors in those markets.

The latest scandal in the commodities industry involves Peregrine Financial Group and its owner Russell Wasendorf. The CFTC announced today that it filed a complaint against Peregrine Financial Group Inc. (PFG), a registered futures commission merchant, and its owner, Russell R. Wasendorf, Sr. (Wasendorf). The Complaint alleges that PFG and Wasendorf committed fraud by misappropriating customer funds, violated customer fund segregation laws, and made false statements in financial statements filed with the Commission.

The National Futures Association (NFA) is PFG’s Designated Self-Regulatory Organization and is responsible for monitoring and auditing PFG for compliance with the minimum financial and related reporting requirements. According to the Complaint, in July 2012 during an NFA audit, PFG falsely represented that it held in excess of $220 million of customer funds when in fact it held approximately $5.1 million.

The Commission’s action alleges that from at least February 2010 through the present, PFG and Wasendorf failed to maintain adequate customer funds in segregated accounts as required by the Commodity Exchange Act and CFTC Regulations. The Complaint further alleges that defendants made false statements in filings required by the Commission regarding funds held in segregation for customers trading on U.S. Exchanges.

According to the Complaint, Wasendorf attempted to commit suicide yesterday, July 9, 2012. In the aftermath of that incident, the staff of the NFA received information that Wasendorf may have falsified certain bank records.

The SEC charged Texas-based medical device company Orthofix International N.V. with violating the Foreign Corrupt Practices Act (FCPA) when a subsidiary paid routine bribes referred to as “chocolates” to Mexican officials in order to obtain lucrative sales contracts with government hospitals. Orthofix agreed to pay $5.2 million to settle the SEC's charges.

The SEC alleges that Orthofix’s Mexican subsidiary Promeca S.A. de C.V. bribed officials at Mexico’s government-owned health care and social services institution Instituto Mexicano del Seguro Social (IMSS). The “chocolates” came in the form of cash, laptop computers, televisions, and appliances that were provided directly to Mexican government officials or indirectly through front companies that the officials owned. The bribery scheme lasted for several years and yielded nearly $5 million in illegal profits for the Orthofix subsidiary.

The SEC's proposed settlement is subject to court approval. Orthofix consented to a final judgment ordering it to pay $4,983,644 in disgorgement and more than $242,000 in prejudgment interest. The final judgment would permanently enjoined the company from violating the books and records and internal controls provisions of the FCPA. Orthofix also agreed to certain undertakings, including monitoring its FCPA compliance program and reporting back to the SEC for a two-year period.

Orthofix also disclosed today in an 8-K filing that it has reached an agreement with the U.S. Department of Justice to pay a $2.22 million penalty in a related action.

The SEC's next Open Meeting will be held on July 11, 2012. The subject matter of the Open Meeting will be:

The Commission will consider whether to adopt Rule 613 under Section 11A of the Securities Exchange Act, to require national securities exchanges and national securities associations to submit a national market system (“NMS”) plan to develop, implement, and maintain a consolidated order tracking system, or consolidated audit trail, with respect to the trading of NMS securities, that would capture customer and order event information for orders in NMS securities, across all markets, from the time of order inception through routing, cancellation, modification, or execution.

Last week the SEC unanimously approved rules and interpretations for key definitions of certain derivative products. They further define the terms “swap” and “security-based swap” and whether a particular instrument is a “swap” regulated by the Commodity Futures Trading Commission (CFTC) or a “security-based swap” regulated by the SEC. The SEC action also addresses “mixed swaps,” which are regulated by both agencies, and “security-based swap agreements,” which are regulated by the CFTC but over which the SEC has antifraud and other authority.

The rules and interpretations were written jointly with the CFTC implement provisions of the 2010 Dodd-Frank Act that establish a comprehensive framework for regulating over-the-counter derivatives. Once both agencies adopt the final rules, they will become effective 60 days after the date of publication in the Federal Register. The compliance date of such rules for purposes of certain interim exemptions under the federal securities laws will be 180 days after the date of publication in the Federal Register. The final rule text and a fact sheet will be available after both agencies adopt the final rules.

I recommend that federal bank, commodity, and securities regulators jointly modify the manner in which financial intermediaries market investment transactions in order to provide investors with quantitative information that facilitates comparison across products and understanding of risk. On its face, the Dodd-Frank Act does little to address the balkanization of business conduct standards but continues Congress’s policy of classifying the obligations of financial services providers by regulatory category (e.g., “securities,” “derivatives,” “banking,” “consumer finance”). To the extent that opponents of harmonization dwell on the talismanic significance of words such as “fiduciary,” “suitability,” and “duty of care,” I propose a safe harbor that distills the essence of a fiduciary’s obligations to permit consistent application across all financial services products.

This short essay, written for a symposium on The Principles and Politics of Aggregate Litigation: CAFA, PSLRA, and Beyond, decouples due process from a proceduralist’s intuition and explains why it matters in securities class actions. It begins by exploring several analytical models that shed light on the representative relationship in class actions, including a public law analogy to the administrative state, a private law analogy to corporate law, and another, more modern public law analogy to political governance. After finding that the political-governance model best addresses both sources of inadequate representation in securities class actions — rifts between class members and class counsel, and between class members and their lead plaintiff — this Essay argues that incorporating qualified class members into securities class action governance will improve due process and legitimacy in securities litigation just as it does in the political sphere

The Volcker Rule was designed to strike a compromise between reestablishing the firewall between investment and commercial banking activities under the Glass-Steagall Act and retaining the synergistic benefits of bundling such services championed by the Gramm-Leach-Bliley Act. This paper will approach the topic from the perspective of regulators who must grapple with the Rule’s implementation. On the one hand, the financial community can be expected squarely to resist any aggressive implementation of the Rule; on the other, failure to adopt a set of rules and an associated supervisory program would almost surely result in regulators taking significant heat if the Rule does not at least have some impact on the configuration of Wall Street’s activities. Moreover, such efforts must be implemented in a manner that complements other initiatives mandated by Dodd-Frank.

The regulators have staked out a three-pronged approach in their proposed rulemaking: (i) formalizing the classification of trading activities, (ii) adopting quantitative measures, and (iii) mandating a system of internal controls that provides a roadmap for regulatory compliance, supervision, and enforcement. This paper considers the arguments made for and against the Rule’s restrictions on proprietary trading, analyzes the public debate over the proposed implementation of the Rule, and offers some remarks on how regulators might advance the Rule’s moral imperative.

The SEC charged Axius, Inc., its President and CEO, Roland Kaufmann, and stock promoter Jean-Pierre Neuhaus with engaging in a fraudulent broker bribery scheme designed to manipulate the market for Axius’ common stock. According to the SEC's complaint, beginning in at least January 2012, Kaufmann and Neuhaus engaged in an undisclosed kickback arrangement with an individual (“Individual A”) who claimed to represent a group of registered representatives with trading discretion over the accounts of wealthy customers. Kaufmann and Neuhaus promised to pay kickbacks of between 26% and 28% to Individual A and the registered representatives he purported to represent in exchange for the purchase of up to $5 million of Axius stock through the customers’ accounts.

The complaint further alleges that on February 16 and 17, 2012, Kaufmann instructed Individual A to purchase approximately 14,000 shares of Axius stock for a total of approximately $49,000 through matched trades using detailed instructions concerning the size, price and timing of the purchase orders. Thereafter, Kaufmann paid Individual A bribes of approximately $13,700.

The Commission seeks permanent injunctive relief, disgorgement of ill-gotten gains, plus pre-judgment interest, and civil penalties from all defendants, an order prohibiting Neuhaus and Kaufmann from participating in any offering of penny stock, and an order prohibiting Kaufmann from serving as an officer or director of a public company.

FINRA's new Know-Your-Customer (Rule 2090) and Suitability (Rule 2111) Rules go into effect on July 9. The SEC approved the rules in November 2010. The rules are essentially a reworking of the prior NYSE and NASD rules, but they have engendered some anxiety in the industry. FINRA delayed the original effective date of Oct. 7, 2011 because members expressed the need for more time to update procedures, modify automated systems and educate associated persons. FINRA has also issued three Notices providing guidance on the rules' requirements (NTM 11-02, 11-25, 12-25).

So what do the rules require?

New FINRA Rule 2090 (Know Your Customer), based on the prior NYSE Rule, requires firms to “use reasonable diligence, in regard to the opening and maintenance of every account, to know (and retain) the essential facts concerning every customer….” For purposes of the rule, essential facts are “those required to (a) effectively service the customer’s account, (b) act in accordance with any special handlinginstructions for the account, (c) understand the authority of each person acting on behalf of the customer, and (d) comply with applicable laws, regulations, and rules.”

New FINRA Rule 2111 (Suitability), based on the prior NASD rule, requires that a firm or associated person “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile.” Paragraph (b) of the Rule provides an exemption for institutional accounts.

In the supplementary material to Rule 2111, FINRA explains that "investment strategy" is to be interpreted broadly. However, certain communications are excluded so long as they do not include a recommendation of any particular security: general financial and investment information, descriptive information about an employee-sponsored retirement or benefit plan, asset allocation models that meet certain requirements, and interactive investment materials that incorporate the above.

The supplementary material also sets forth what FINRA has previously described as the components of the suitability obligation:

Reasonable-Basis Suitability. The firm must have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors. Importantly, "[a] member's or associated person's reasonable diligence must provide the member or associated person with an understanding of the potential risks and rewards associated with the recommended security or strategy. The lack of such an understanding when recommending a security or strategy violates the suitability rule."

Customer-Specific Obligation. The firm or associated person must have a reasonable basis to believe that the recommendation is suitable for a particular customer based on that customer's investment profile.

Quantitative Suitability addresses excessive trading in a customer's account and requires a firm or associated person who has actual or de facto control over the account to have a reasonable basis for believing that a series of transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together in light of the customer's investment profile.

Why have these rules created anxiety among broker-dealers? In NTM 11-25, FINRA stated that questions from broker-dealers focused on information-gathering requirements in relation to a customer’s investment profile, the scope of the term “strategy,” and reasonable-basis obligations. In NTM 12-25, FINRA identified further concerns: theobligation to act in a customer’s best interests; the scope of the terms “recommendation,” “customer” and “investment strategy”; the use of a risk-based approach to documenting suitability; information gathering requirements; reasonable-basis and quantitative suitability; and the institutional-customer exemption.

FINRA has tried to provide reassurance to members. In NTM 12-25, for example:

FINRA reiterates, however, that many of the obligations under the new rule are the same as those under the predecessor rule and related case law. Existing guidance and interpretations regarding suitability obligations continue to apply to the extent that they are not inconsistent with the new rule. Furthermore, FINRA appreciates that no two firms are exactly alike. Firms have different business models; offer divergent services, products and investment strategies; and employ distinct approaches to complying with applicable regulatory requirements. FINRA’s guidance is not intended to influence any firm’s choice of a particular business model or reasonable approach to ensuring compliance with suitability or other regulatory requirements.

FINRA recently posted on its website a request for public comment on proposed regulation of crowdfunding activities. (Download FINRA.NTM12-34) The JOBS Act requires that intermediaries performing crowdfunding on behalf of issuers must register with the SEC as a "funding portal" or broker and must register with an applicable SRO. FINRA seeks comment on the appropriate scope of FINRA rules that should apply to member firms engaged in crowdfunding activities.

As FINRA noted in its Notice to Members:

The regulatory scheme established by Congress expressly contemplates a role for an organization such as FINRA by mandating that each registered funding portal be a member of an applicable SRO. However, Congress limited a national securities association’s examination and enforcement authority over such registered funding portals to its rules“written specifically for registered funding portals.”

Accordingly, FINRA seeks comment on two categories of rules: those that would apply specifically to members acting as funding portals and those applicable to members acting as brokers. According to the Notice:

In writing rules specifically for registered funding portals, FINRA would seek to ensure that the capital-raising objectives of the JOBS Act are advanced in a manner consistent with investor protection. Commenters are encouraged to identify the types of requirements that should apply to registered funding portals, taking into account the relatively limited scope of activities by a registered funding portal permitted under the JOBS Act. Comments are particularly requested about possible rules concerning supervision, advertising, anti-money laundering, fraud and manipulation, and just and equitable principles of trade.

FINRA also solicits comment on the application of existing FINRA rules to crowdfunding activities of broker-dealers. Unlike the rules applicable to registered funding portals, the JOBS Act does not limit the FINRA rules applicable to registered broker-dealers engaging in crowdfunding activities. Nevertheless, FINRA invites comments from broker-dealers regarding the application of existing FINRA rules to broker-dealers’ crowdfunding activities and whether such rules should be relaxed to address a broker-dealer’s crowdfunding activities, taking into account, among other things, the extent to which a broker-dealer may be able to isolate its crowdfunding business, or otherwise places limitations on its activities akin to those for registered funding portals. FINRA requests information from broker dealers that may engage in crowdfunding concerning the organizational structure through which this activity would occur within the firm (e.g., through the broker-dealer entity or a separately identified department). FINRA also requests comment on whether engaging in crowdfunding might present special conflicts or concerns for a broker-dealer, such as might arise if a registered representative were to recommend that a customer visit the firm’s crowdfunding site.

The Second Circuit summarily affirmed a district court's confirmation of a $20.5 million arbitration award against Goldman Sachs Execution & Clearing L.P. The claimants, the unsecured creditors committee of Bayou Group, LLC, asserted that the clearing firm had "red flags" to alert them that Bayou was in fact a Ponzi scheme. Goldman Sachs unsuccessfully argued that the award was "in manifest disregard of the law." The Second Circuit, noting that the manifest disregard standard is, by design, exceedingly difficult to satisfy, agreed with district court that Goldman had not satisfied it. Goldman Sachs Execution & Clearing, L.P. v. Official Unsecured Creditors' Committee of Bayou Group LLC (2d Cir. July 3, 2012).